The danger of subprime mortgages
I have been seeing a lot of this term "subprime mortgages" in the past weeks - a term I have never hear of before in the past. It seems to be the cause of the recent stock market plunge. I could never understand all those stuff written to explain it until this article by Tan Kim Lian (in MyPaper on 14th Aug). Boy, he is good. It is too good not to share:
"Why are the subprime mortgages in America causing problems to the global stockmarkets? Surely the economy in Asia is growing strongly. Why should it be affected by the mortgages in America?
The subprime mortgages were issued in America. A batch of mortgages are put into a portfolio, called "asset-backed security" (ABS). This portfolio is divided into different tranches. The most secure tranches were rated AAA. The BBB tranche is high risk. The least secure are the equity tranche.
The investment bankers take the BBB tranches of many portfolios and put them into a new portfolio called a CDO (collateralised debt obligation). The CDO is again issued into several tranches, from AAA and equity tranche.
The AAA tranche of the CDO is actually comprise of many BBB tranches of the ABS (which are high risk). These CDOs are sold to funds in Europe and Asia.
When the American property market falls in value, many of the subprime mortgages defaulted. This affects the BBB tranches of the ABSs and nearly all of the tranches of the CDOs. The AAA and AA tranches of the CDOs have fallen in value, by a lot.
Many banks invested in these CDOs. When they fall in value, the banks have to book the losses. This caused their stock price to fall. This is affecting the stockmarkets around the world.
Some of the money raised by the structured products sold in Singapore were also invested in the CDOs. They have also falled in value.
There is nothing much that the investor can do about these structured products. If they withdraw now, they will suffer huge losses. They can only wait for the maturity date. and hope that the market would have recovered.
If you read some of the structured products, they said that the investor can lose part or all of the principal. It can happen. Let's hope that it does not."
I am thinking isn't it unethical to repackage BBB grade products and pass them off as AAA grade. That is so sneaky. People who are not aware there is a difference will be misled into buying into such financial products. Are there more of such products out there besides subprime mortgages? Shudder.
"Why are the subprime mortgages in America causing problems to the global stockmarkets? Surely the economy in Asia is growing strongly. Why should it be affected by the mortgages in America?
The subprime mortgages were issued in America. A batch of mortgages are put into a portfolio, called "asset-backed security" (ABS). This portfolio is divided into different tranches. The most secure tranches were rated AAA. The BBB tranche is high risk. The least secure are the equity tranche.
The investment bankers take the BBB tranches of many portfolios and put them into a new portfolio called a CDO (collateralised debt obligation). The CDO is again issued into several tranches, from AAA and equity tranche.
The AAA tranche of the CDO is actually comprise of many BBB tranches of the ABS (which are high risk). These CDOs are sold to funds in Europe and Asia.
When the American property market falls in value, many of the subprime mortgages defaulted. This affects the BBB tranches of the ABSs and nearly all of the tranches of the CDOs. The AAA and AA tranches of the CDOs have fallen in value, by a lot.
Many banks invested in these CDOs. When they fall in value, the banks have to book the losses. This caused their stock price to fall. This is affecting the stockmarkets around the world.
Some of the money raised by the structured products sold in Singapore were also invested in the CDOs. They have also falled in value.
There is nothing much that the investor can do about these structured products. If they withdraw now, they will suffer huge losses. They can only wait for the maturity date. and hope that the market would have recovered.
If you read some of the structured products, they said that the investor can lose part or all of the principal. It can happen. Let's hope that it does not."
I am thinking isn't it unethical to repackage BBB grade products and pass them off as AAA grade. That is so sneaky. People who are not aware there is a difference will be misled into buying into such financial products. Are there more of such products out there besides subprime mortgages? Shudder.
posted by Fiery at Sunday, August 19, 2007
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